China's IT outsourcing firms aim to move up the value chain

Microsoft, IBM and other multinational companies have long been customers for VanceInfo, one of China's largest IT outsourcing firms. With more than 11,000 employees, VanceInfo leverages China's low-cost work force to develop products and enterprise software for many of its clients.

But continuing to rely on low-cost labor to attract business is becoming outdated, said Ken Schulz, vice president of global marketing for the company.

Facing rising labor wages and increased competition, Chinese IT outsourcing firms like VanceInfo intend to provide more that just cost savings for their customers.

"In order to tap the market, we can't just focus on staffing," Schulz said. "We don't want to get paid for the people, but get paid for the solutions we can provide."

While India is home to the world's largest outsourcing firms, multinational companies have also looked to outsourcing firms in China, not only due to the country's equally low-cost labor force, but also with the aim of tapping the country's vast market.

Companies like VanceInfo, which was founded in 1995, have seen demand for their services surge as a result. In 2011, the company's revenues are forecasted to reach US$275 million, a year-on-year increase of 30 percent. Staffing has also increased from 3,700 in 2007 to 11,600 in 2010.

VanceInfo's past work has included localizing products for the Chinese market. But as foreign companies have relied on outsourcing firms like VanceInfo, so have China's own domestic IT companies, which have also exploded in growth. In 2006, only 5 percent of VanceInfo's customer base came from China, Schulz said. Now that number has reached 45 percent, with VanceInfo's U.S. customers at 34 percent.

"Chinese companies have their own IT departments, but they want to build up their IT capabilities. They are facing competition and they want to go global," Schulz said.

HiSoft, another major Chinese IT outsourcing company, has seen the same kind of growth. While most of the company's customers come from the U.S. and Japan, now 17 percent of HiSoft's client base is from China, which include Internet companies, banks and telecommunication companies. Two years ago, that percentage was zero, said HiSoft CEO Tiak Koon Loh.

"We have served international clients like Microsoft and GE (General Electric). They have been outsourcing to vendors for a long time. So we took the best practices and what we learned from them and leveraged that to build capabilities to serve our Chinese customers," he said.

China's market growth, its huge talent pool and Chinese government tax incentives have all helped drive the industry, according to outsourcing firms in the country. But to stay competitive, outsourcing companies have had to cut costs as they deal with rising wages due to the Chinese Yuan's appreciation.

In the cases of VanceInfo and HiSoft, both companies have migrated parts of their business further inland to smaller cities, where wages are lower compared with Beijing and Shanghai.

But in the future, China's cost-saving advantage will grow weaker, said Chen Ximin, COO of Neusoft, another major Chinese outsourcing company with more than 18,000 employees. Furthermore, multinational companies want more than just low-cost labor, but complete product solutions, Chen said.

"We have to leave behind this thinking of just offering a simple cost-saving advantage," he said. "The advantage won't last, and it's something we have all been aware of."

To meet the challenge, Chinese IT outsourcing companies have shifted toward being providers of customized enterprise software. Products can involve building online banking programs or creating software used to support telecommunication networks. At the same time, the companies have been more active in investing in research and development projects.

But while Chinese IT outsourcing firms try to leverage their own advantages, they still fall behind their Indian rivals in terms of scale. Infosys, one of India's largest IT outsourcing firms, employs 130,000 people, ten times more than the largest IT outsourcing companies in China. This allows the Indian firm to take on bigger projects.

Chinese companies like Neusoft and VanceInfo aim to better compete by expanding near-shore offices in countries like the U.S. and Europe, where Indian outsourcing companies already have a presence.

In spite of the challenges, the market for China's IT outsourcing firms is only expected to grow, said Tina Tang, an analyst with research firm Gartner.

"China will obviously become a bigger player," she said. "Even as it will have to compete with other countries, China can become a provider of high-level IT services."

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